WEEK 1
📚 What is Accounting?
Accounting is described in several ways:

Language of the Business: It is the language used by managers to communicate the firm's financial and
economic information to internal & external stakeholders.

Service Activity: Its function is to provide quantitative information, primarily financial in nature, about economic
entities that is intended to be useful in economic decisions.

An Information System: An information system that measures, processes and communicates financial
information about an economic entity.

A Process: Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by users of the information.

An Art: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are, in part at least, of a financial character, and interpreting the results
thereof.
💼 Applications and Roles of Accounting
Accounting helps with several key business and financial activities:

Budgeting: An estimation of revenue and expenses over a specified future period of time and is usually compiled
and re-evaluated on a periodic basis.
o

Financial Planning: The process of taking a comprehensive look at your financial situation and building a specific
financial plan to reach your goals.
o

Case in Point: Trisha's cupcake business is struggling. By reviewing her accounting reports, she discovered
she spends too much on packaging materials.
Financial Analysis: The process of evaluating businesses, projects, budgets, and other finance-related
transactions to determine their performance and suitability.
o

Case in Point: Margarette, planning to establish her own restaurant, can use accounting to determine
how much to invest and her daily cash needs.
Case in Point: Angelo, an IT Manager, used his accounting knowledge to interpret an expense report and
give feedback to the Board.
Tax Compliance: Means taxpayers' decision to comply with tax laws and regulations by paying taxes timely and
accurately.
o
Case in Point: Rico, who established a call center firm, is not worried about filing tax forms because he
knows accounting will help him get the necessary income & expense information.
👥 Users of Accounting Information
Accounting information is used by various stakeholders:

Owners/Shareholders

Managers

Prospective Investors

Creditors, Bankers, and other Lending Institutions

Government

Employees

Regulatory Agencies

Researchers

Customers
🌳 Branches of Accounting
The common branches of accounting include Auditing, Bookkeeping, Cost Accounting, Financial Accounting, Financial
Management, Management Accounting, Taxation, and Government Accounting.
Branch
Description
Auditing
Refers to financial statement audits or an objective examination and evaluation of a
company's financial statements - usually performed by an external third party.
Bookkeeping
The process of recording your company's financial transactions into organized accounts on a
daily basis.
Cost Accounting
A form of managerial accounting that aims to capture a company's total cost of production by
assessing its variable and fixed costs.
Financial
Accounting
A specific branch of accounting involving a process of recording, summarizing, and reporting
the myriad of transactions resulting from business operations over a period of time.
Financial
Management
The practice of making a business plan and then ensuring all departments stay on track. Solid
financial management enables the CFO or VP of finance to provide data that supports creation
of a long-range vision, informs decisions on where to invest, and yields insights on how to fund
those investments, liquidity, profitability, cash runway and more.
Management
Accounting
The provision of financial data and advice to a company for use in the organization and
development of its business.
Taxation1
Term for when a taxing authority, usually a government, levies or imposes a financial
obligation on its citizens or residents.2
Government
Accounting3
Prepare and review financial documentation for the government and its taxpayers.4
⏳ Brief History of Accounting
World & U.S. History

8000–5000 BC: Earliest evidence of accounting language comes from Mesopotamian civilizations.

Before 2000 BC: Bookkeeping most likely emerged while society was still under a barter system.

1400s: Single-entry bookkeeping is the standard.

1494: Italian monk Luca Pacioli publishes the first document for modern bookkeeping.

1887: The American Association of Public Accountants (AAPA) was established.

1896: The accounting profession is formally recognized, i.e., establishment of the professional title of certified
public accountant (CPA).

1913: The U.S. begins charging income tax to fund the upcoming World War and the need for logistics
skyrockets.

1952: IBM released its first large computer and accountants were among the first to use them.

Present Day: QuickBooks is among the most popular accounting software.
Philippines History

Pre-Spanish era: Accounting is already practiced.

1915: Don Vicente Fabella, first Filipino CPA in USA.

March 17, 1928: Accountancy recognized as a profession under Act. No. 3105.

1928: Dr. Nicanor Reyes founded “Institute of Accountancy” now known as Far Eastern University.

1975: Philippine Institute of Certified Public Accountants was born.

2004: The Philippine Accountancy Act of 2004.

Currently: Board of Accountancy provides CPA Licensure examinations.

CPA Passing % last May 2022: 25.84% (1,722 out of 6,665 Examinees).
🏢 Forms of Business Organizations
Business Type & Description
Advantage
Disadvantage
Sole Proprietor-ship Business with one
owner.
Easy to start; No business
taxes; Keep all profits.
Unlimited liability; Lots of Work.
Partnership Business with 2 or more
owners.
Easy to start; No business
taxes; More revenue
available.
Unlimited liability; Honesty of others
is risky (embezzlement).
Corporation Business treated as an
person under the law.
Limited Liability (No
personal stake); Easy to
raise $\$$ through stocks.
Slow decisions due to levels of
structure; High Corporation &
Business Taxes; Harder to start.
(No advantages listed)
Requires at least fifteen (15)
members; Usually have a set of bylaws.
Cooperative A business that is owned
by its members and also serve as
benefactors to all of the members.



Sole Proprietorship: A business that is owned by only one individual. Requires at least costly form of ownership.
Example: grocery store, repair shop, beauty parlor.
Partnership: A type of business that is owned by two or more individuals. Profits of a business are divided
among the partners. Two forms: General Partnership and Limited Partnership.
Corporation: A business organization with limited liability. Incorporators refer to those who originally formed the
corporation. Evidenced by articles and by-laws approved by SEC.
🏭 Types of Business According to Activities
Business Type
Definition
Advantages
Disadvantages
Service
A company that performs tasks for the
benefit of their customers. These tasks
can include transportation, cleaning,
traveling, hospitality, maintenance or
consulting.
Absence of
inventory; No
production
facilities.
Inability to standardize
services; Maintaining human
capital.
Merchandising
A business that purchases finished
products and resells them to
consumers. Consider your local
grocery store or retail clothing store.
Visible products;
Less conversion,
time, and effort.
Managing inventory.
Manufacturing
Any business that uses components,
parts or raw materials to make a
finished good.
Quality control;
Visible products.
Generally needs production
facilities; High conversion
costs; Cost of quality control;
Managing inventory.
WEEK 2
� Conceptual Framework

A Conceptual Framework is a system of ideas and objectives that lead to the creation of a consistent set of rules
and standards.
Content of the Framework

The objective of general-purpose financial reporting

Qualitative Characteristics of useful information

Financial statements and the reporting entity

The elements of financial statements

Recognition and Derecognition

Measurement

Presentation and Disclosure

Concepts of capital and capital maintenance
📊 Qualitative Characteristics of Useful Information
Fundamental Characteristics
Enhancing
Characteristics
Cost Constraint
Relevance (Predictive Value, Confirmatory
value)
Verifiability (Direct,
Indirect)
Cost-Benefit Balancing
Faithful Representation (Complete, Neutral,
Free from error)
Comparability
Balance Between Qualitative
Characteristics
Understandability
True and Fair View Presentation
Timeliness
Fundamental Characteristics


Relevance is the concept that the information generated by an accounting system should impact the decisionmaking of someone perusing the information.
o
Confirmatory value means that the information provides feedback on previous evaluations.
o
Predictive value refers to the fact that quality financial information can be used to base predictions,
forecasts, and projections on.
Faithful Representation implies that financial information faithfully represents the phenomena it purports to
represent.
o
This is achieved by being Complete, Neutral, and Free From error.
Enhancing Characteristics


Verifiability means it should be possible for an organization's reported financial results to be reproduced by a
third party, given the same facts and assumptions.
o
Direct verification means verifying an amount or other representation through direct observation, for
example, by counting cash.
o
Indirect verification means checking the inputs to a model, formula or other technique and recalculating
the outputs using the same methodology.
Comparability is the level of standardization of accounting information that allows the financial statements of
multiple organizations to be compared to each other.

Understandability implies that preparers of information have classified, characterized and presented the
information clearly and concisely.

Timeliness is how quickly information is available to users of accounting information.
o
The less timely (thus resulting in older information), the less useful information is for decision-making.
📝 Elements of Financial Statements



Financial Position
o
Assets
o
Liabilities
o
Equity
Performance
o
Income
o
Expenses
Capital maintenance
Recognition Concept
Recognition is a process of incorporating in the statement of financial position or income statement an item that meets
the definition of an element and satisfies the criteria for recognition.
Criteria for recognition:

a. Probable that any future economic benefit will flow to or from the enterprise.

b. Item has a cost or value that can be measured with reliability.
Recognition Concepts

Recognition of Assets – probable that the future economic benefits will flow to the enterprise and value that can
be measured reliably.

Recognition of Liabilities – probable that an outflow of resources from settlement of present obligation and
value that can be measured reliably.

Recognition of Income – Increase in future economic benefits related to increase in assets or a decrease in
liability that can be measured reliably.

Recognition of Expenses – Decrease in future economic benefits related to decrease in assets or a increase in
liability that can be measured reliably.
📚 Accounting Concepts and Principles
Basic Accounting Principles

Accounting principles are the rules that an organization follows when reporting financial information.
Measurement Concepts

Historical Cost

Current Cost

Realizable Value

Present Value
Capital Maintenance Concepts
1. Concept of Capital

Financial Concept

Physical Concept
2. Concept of Capital Maintenance

Financial Capital Maintenance

Physical Capital Maintenance
Capital Maintenance Definitions
1. Financial Capital Maintenance - profit is earned only if the amount of net assets at the end of the period
exceeds the net assets at the beginning of the period.
2. Physical Capital Maintenance - profit is earned only if the physical productive capacity at the end of the period
exceeds the physical productive capacity of the beginning of the period.
Basic Accounting Principles/Assumptions Explained

The economic entity principle is an accounting principle that states that a business entity's finances should be
kept separate from those of the owner, partners, shareholders, or related businesses.
o
Illustration: Owners provide capital to the business, and the business entity invests capital in assets and
returns profit to owners. The business and the owner are kept separate.

The monetary unit principle is the assumption that money itself is treated as a unit of measurement, and that all
transactions or economic events recorded in the accounts of a business can be expressed and measured in
monetary terms by a currency.

The specific time period assumption is an accounting principle which states that a business should report their
financial statements appropriate to a specific time period.

The full disclosure principle is a concept that requires a business to report all necessary information about their
financial statements and other relevant information to any persons who are accustomed to reading this
information.

The going concern principle is a fundamental principle of accounting. It assumes that during and beyond the
next fiscal period a company will complete its current plans, use its existing assets and continue to meet its
financial obligations.

The matching principle requires that revenues and any related expenses be recognized together in the same
reporting period.

Accrual basis is a method of accounting where revenues and expenses are recorded when they are earned,
regardless of when the money is actually received or paid.

Materiality refers to the relative size of an amount.
o
o

Relatively large amounts are material, while relatively small amounts are not material (or immaterial).
Determining materiality requires professional judgement.
Conservatism is a principle that requires company accounts to be prepared with caution and high degrees of
verification.
o All probable losses are recorded when they are discovered, while gains can only be registered when they
are fully realized.
WEEK 3
📘 Basic Accounting Equation
Accounting Equation
ASSETS = LIABILITIES + OWNER'S EQUITY
This equation will always hold true, regardless of economic transaction
ASSETS = LIABILITIES + OWNER'S EQUITY
Possibilities:

Increase in asset = decrease in another asset

Increase in asset = increase in liability

Increase in asset = increase in equity

Decrease in asset = decrease in liability

Decrease in asset = decrease in equity

Increase in liability = decrease in another liability

Increase in liability = decrease in equity

Decrease in liability = increase in equity

Increase in equity = decrease in another equity
Ex: Paul established a business named DJ Company. On the same day, he invested P1,000,000 in the company.
ASSETS = LIABILITIES + OWNER'S EQUITY
Jan 3 balance
Assets
=
Liabilities
+
Equity
Cash P1,000,000
=
P0
+
Paul, Capital P1,000,000
Ex: DJ Company purchased office supplies for P10,000 cash.
ASSETS = LIABILITIES + OWNER'S EQUITY
Jan 3 balance
Assets
= Liabilities + Equity
Cash 1,000,000$
= P0
+ Paul, Capital P1,000,000
Jan 5 transaction Cash 10,000)$ + Supplies 10,000$ = P0
+ P0
Jan 5 balance
+ Paul, Capital P1,000,000
Cash 990,000$ + Supplies 10,000$ = P0
Ex: DJ Company purchased office equipment, 50,000$ on account.
ASSETS = LIABILITIES + OWNER'S EQUITY
Assets
= Liabilities
+ Equity
Jan 5 balance
Cash 990,000$ + Supplies 10,000$
= 0$
+
Jan 6
transaction
Equipment 50,000$
=
Accounts payable
50,000$
+ 0$
Jan 6 balance
Cash 990,000$ + Supplies 10,000$ + Equipment
50,000$
=
Accounts payable
50,000$
+
Paul, Capital
1,000,000$
Paul, Capital
1,000,000$
Ex: DJ Company will assume the personal liability of Paul, the owner: accounts payable amounting to 7,000$
ASSETS = LIABILITIES + OWNER'S EQUITY
Assets
= Liabilities
+ Equity
Jan 6 balance
Cash + Supplies + Equipment 990,000 +
10,000 + 50,000$
=
Accounts payable
50,000$
+
Jan 10
transaction
0$
=
Accounts payable
7,000$
+ Paul, Capital 7,000$
Jan 10 balance
Cash + Supplies + Equipment 990,000 +
10,000 + 50,000$
=
Accounts payable
57,000$
+ Paul, Capital 993,000$
Paul, Capital
$\text{P}1,000,000$
Expanded Accounting Equation
ASSETS = LIABILITIES + OWNER'S EQUITY
INCOME (+) EXPENSES (-)
Ex: DJ company collected }20,000$ cash from clients for rendering professional services.
Assets
= Liabilities
Jan 10 bal.
Cash + Supplies + Equipment
990,000 + 10,000 + }50,000$
=
Jan 15
transaction
Cash 20,000$
= 0$
Jan 15 bal.
Cash + Supplies + Equipment
1,010,000 + 10,000 + 50,000$
=
+ Equity
Accounts
Paul, Capital
+
payable 57,000$
993,000$
+ 0$
Accounts
Paul, Capital
+
payable 57,000$
993,000$
Income
- Expenses
Professional fees
0$
- 0$
Professional fees
20,000$
- $
Professional fees
20,000$
- 0$
Ex: DJ company paid 5,000$ cash from clients for rendering professional services (Note: The example is likely meant to
illustrate paying an expense, as suggested by the table)
Assets
= Liabilities
+ Equity
Jan 15 Bal.
Accounts
Cash + Supplies + Equipment
= payable
1,010,000 + 10,000 + 50,000$
57,000$
+
Jan 27
transaction
Cash 5,000$
+ 0$
Jan 27 Bal.
Accounts
Cash + Supplies + Equipment
= payable
1,005,000 + 10,000 + 50,000$
57,000$
= 0$
+
Paul, Capital
993,000$
Paul, Capital
993,000$
Income
- Expenses
Professional fees
- 0$
20,000$
0$
Repairs
- expense
5,000$
Repairs
Professional fees
- expense
20,000$
5,000$
WEEK 3
📑 The Account
Account Definition

An account is a record in an accounting system that tracks the financial activities of a specific asset, liability,
equity, revenue, or expense.12

These records increase and decrease as the business events occur throughout the accounting period.34

Each individual account is stored in the general ledger and used to prepare the financial statements at the end of
an a5ccounting period.
� The Accounting Equation and The Five Major Accounts
The fundamental relationship in accounting is represented by the Accounting Equation:
$$\text{ASSETS} = \text{LIABILITIES} + \text{OWNER'S EQUITY}$$
This equation is expanded by considering Income $(+)$ and Expenses $(-)$ as components that affect Owner's Equity.
The Five Major Accounts (Elements of Financial Statements)
Element
Definition / Description
Asset
A present economic resource controlled by the entity as a result of past events. An economic resource is a
right that has the potential to produce economic benefits.6
Element
Definition / Description
Liability7
A present obligation of the entity to transfer an economic resource as a result of past events.89
Equity10
The residual interest in the assets of the entity after deducting all its liabilities.11
Income12
Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relatin13g
to contributions from holders of equity claims.14
Expenses15
Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to
distributions to holders of equity claims.16
Detailed Definitions
1. Assets

A present economic resource controlled by the entity as a result of past events.

Economic Resource - is a right that has the potential to produce economic benefits.
o
o
o
An economic resource could produce economic benefits for an entity by entitling or enabling it to do, for
example, any one or more of the following:

Receive contractual cash flows or another economic resource.

Exchange economic resources with another party on favorable terms.

Produce cash inflows or avoid cash outflows.

Receive cash or other economic resources by selling the economic resource.

Extinguishes liabilities by transferring the economic resource.
A. Rights that correspond to an obligation of another party, for example:

Rights to receive cash

Rights to receive goods and services

Rights to exchange economic resources with another party on favorable terms (e.g. Right to buy
specific goods thru forward contracts)

Rights to benefit from an obligation of another party to transfer an economic resource if a
specified uncertain future event occurs
B. Rights that do not correspond to an obligation of another party, for example:

Rights over physical objects, such as property, plant and equipment or inventories. Example,
rights to use a rented space.

Rights to use intellectual property
2. Liabilities

Liability is a present obligation of the entity to transfer an economic resource as a result of a past event. For a
liability to exist, three criteria must ALL be satisfied:17
o
The entity has an obligation;18
o
The obligation is to transfer an economic resource; and19
o
The obligation is a present obligation that exists as a result of past events.20
3. Owner's Equi21ty (Equity)

Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

In a sole proprietorship, there is only one owner's equity account because there is only one owner.22

In a partnership, an owner's equity account exists for each partner.23

In a corporation, owner's equity or stockholder's equity consists of share capital, retained earni24ngs and
reserves representing appropriations of retained earnings among others.
4. Income and 5. Expenses

Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those
relating to contributions from holders of equity claims.25

Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those
relating to distributions to holders of equity claims.26
📘 Chart of Accounts
Definition of Chart of Accounts

A financial, organizational tool that provides an index of every account in an accounting system.

This provides an insight into all the financial transactions of the company.
Common Account Titles (Assets)
No.
Account Title
Current
Assets
Cash and other assets that are expected to be
converted to cash within a year.
To
Description/Explanation of Account
Increase
101
Cash
Debit
Checking account balance (as shown in
company records), currency, coins,
checks received from customers but not
yet deposited.
120
Accounts Receivable
Debit
Amounts owed to the company for
services performed or products sold but
not yet paid for.
140
Merchandise Inventory
Debit
Cost of merchandise purchased but has
not yet been sold.
150
Supplies
Debit
Cost of supplies that have not yet been
used. Supplies that have been used are
recorded in Supplies Expense.
160
Prepaid Insurance
Debit
Cost of insurance that is paid in advance
and includes a future accounting period.
Noncurrent
Assets
A company's long-term investments that are not easily
converted to cash or are not expected to become cash
within an accounting year. Also known as long-term
assets, their costs are allocated over the number of
years the asset is used and appear on a company's
balance sheet.27
170
Land
Debit
Cost to acquire and prepare lan31d for
use by the company.
175
Buildings
Debit
Cost to purchase or construct buildings
for use by the company.
178
Accumulated Depreciation – Buildings
Credit
Amount of the buildings’ cost that has
been allocated to Depreciation Expense
since the time the building was acquired.
180
Equipment
Debit
Cost to acquire and prepare equipment
for use by the company.
Credit
Amount of equipment's cost that has
been allocated to Depreciation Expense
since the time the equipment was
acquired.
188
Accumulated Depreciation – Equipment
🗄️ Common Account Titles
1. Assets
Current Assets
Current assets are cash and other assets that are expected to be converted to cash within a year.

Cash – any medium of exchange that a bank will accept for deposit at face value. It includes coins, currency,
checks, money orders, bank deposits and drafts.

Cash equivalents – Short-term, highly liquid investments that are readily convertible to known amounts of cash
and which are subject to insignificant risk of changes in value.

Notes Receivable – A written pledge that the customer will pay the business a fixed amount of money on a
certain date.

Accounts Receivable – These are claims against customers arising from sale of services or goods on credit. This
type of receivable offers less security than a promissory note.

Inventories – These are assets which are:

o
A. held for sale in the ordinary course of business
o
B. in the process of production for such sale
o
C. in the form of materials or supplies to be consumed in the production process or in the rendering of
services
Prepaid Expenses – Expenses paid for by the business in advance. Example: Prepaid Rent and Prepaid Insurance.
Non-current Assets
Non-current assets are a company's long-term investments that are not easily converted to cash or are not expected to
become cash within an accounting year.

Property, Plant & Equipment – tangible assets that are held by an enterprise for use in the production or supply
of goods or services or for rental to others, or for administrative purposes, and which are expected to be used
during more than one period.

Accumulated Depreciation – It is a contra account that contains the sum of the periodic depreciation charges.
The balance in this account is deducted from the cost of the related asset – equipment or buildings – to obtain
book value.

Intangible Assets – Identifiable, nonmonetary assets without physical substance held for use in the production
or supply of goods or services, for rental to others, or for administrative purposes. Ex: patents, goodwill,
copyrights, licenses, franchises, trademarks, brand names, secret processes, etc.
2. Liabilities

Current Liabilities – liabilities expected to be settled within 1 year or within the normal operating cycle.

Non-current Liabilities – all other liabilities.
Current Liabilities

Accounts Payable – this account represents the reverse relationship of the accounts receivable. By accepting the
goods or services, the buyer agrees to pay for them in the near future.

Notes Payable – is like a note receivable but in a reverse sense. The business entity is the maker of the note, that
is, the business entity is the party who promises to pay the other party a specified amount of money on a
specified future date.

Accrued liabilities – amounts owed to others for unpaid expenses. This account includes salaries payable,
utilities payable, interest payable and taxes payable.

Unearned Revenues – When the business entity receives payment before providing its customers with goods or
services.

Current portion of a long-term debt – There are portions of mortgage notes, bonds and other long-term
indebtedness which are to be paid within one year from the balance sheet date.
Non-current Liabilities

Mortgage Payable – This account records long-term debt of the business entity for which the business entity has
pledged certain assets as security to the creditor.

Bonds Payable – Business organizations often obtain substantial sums of money from lenders to finance the
acquisition of equipment and other needed assets. The bond is a contract between the issuer and the lender
specifying terms of repayment and the interest to be charged.
3. Equity (Owner's Equity)

Capital – this account is used to record the original and additional investments of the owner of the business
entity.

Withdrawals – When the owner of a business entity withdraws cash or other assets, such are recorded in the
drawing or withdrawal account rather than directly reducing the owner's equity account.

Income Summary – It is a temporary account used at the end of the accounting period to close income and
expenses. This account shows the profit or loss for the period before closing to the capital account.
4. Income

Service Income – Revenues earned by performing services for a customer or a client. For example, accounting
services by a CPA firm, laundry services by a laundry shop.

Sales – Revenues earned as a result of sale of merchandise. For example, sale of building materials by a
construction supplies firm.
5. Expenses

Cost of Sales – the cost incurred to purchase or to produce the products sold to customers during the period;
also called cost of goods sold.

Salaries or Wages Expense – Includes all payments as a result of an employer-employee relationship such as
salaries or wages, 13th month pay, cost of living allowances and other related benefits.

Telecommunications, Electricity, Fuel and Water Expenses – Expenses related to use of telecommunications
facilities, consumption of electricity, fuel and water.

Rent Expense – Expense for space, equipment or other asset rentals.

Supplies Expense – Expense for supplies that have been used.

Insurance Expense – Portion of premiums paid on insurance coverage (e.g. on motor vehicle, health, life, fire,
typhoon, flood) which has expired.

Depreciation Expense – The portion of the cost of a tangible asset (e.g. buildings and equipment) allocated or
charged as expense during an accounting period.

Uncollectible Accounts Expense – the amount of receivables estimated to be doubtful of collection and charged
as expense during an accounting period.

Interest Expense – An expense related to use of borrowed funds.
WEEK 5
📘 Double Entry System

is a method of recording transactions where for every business transaction, an entry is recorded in at least two
accounts as a debit or credit.

In a double-entry system, the amounts recorded as debits must be equal to the amounts recorded as credits.
🗂️ T-account

Account Name
is an informal term for a set of financial records that use double-entry bookkeeping.
Debit | Credit
⚖️ Normal Balances of Accounts

The normal balance of an account is the side of the account that is positive or increasing.
📊 Combine ALE Equation & the T-account
DEBIT=CREDIT=
ASSET=LIABILITIES+EQUITY


ASSET (on the Debit side)
o
EXPENSE
o
WITHDRAWAL
LIABILITIES + EQUITY (on the Credit side)
o
EQUITY includes:

INCOME

CAPITAL
Normal Balances

Asset, Expenses, Withdrawals = DEBIT

Liabilities, Income, Capital = CREDIT
📝 Double Entry System Example (Journal Entry)
2022 Account Titles
DEBIT
OCT 1 Cash
50,000$ -
Java, Capital
-
CREDIT
50,000$
Java made additional investments
FINANCIAL REPORTING FOR MERCHANDISING BUSINESS
📦 Merchandise Inventory:

Merchandise Inventory (Inventory or MI) refers to the goods the company has purchased and intends to sell to
others.

Inventory is a current asset since the company intends to sell it within one year.3
📈 INVENTORY SYSTEM

A periodic inventory system is a form of inventory valuation where the inventory account is updated at the end
of an accounting period rather than after every sale and purchase. The method allows a business to track its
beginning inventory and ending inventory within an accounting period.

A perpetual inventory system is a program that continuously estimates your inventory based on your electronic
records, not a physical inventory. This system starts with the baseline from a physical count and updates based
on purchases made in and shipments made out.
📅 PERIODIC INVENTORY
The periodic inventory system is often used by smaller businesses that have easy-to-manage inventory and may not have
a lot of money or the opportunity to implement computerized systems into their workflow. As such, they use occasional
physical counts to measure their inventory and the cost of goods sold (COGS).
COGS is an important accounting metric, which, when subtracted from revenue, shows a company's gross margin. The
COGS under the periodic inventory system is calculated as follows:
COGS = BEGINNING BALANCE OF INVENTORY + COST OF INVENTORY PURCHASE – COST
🛒 Purchasing Transactions:

Inventory account is increased for the cost of the merchandise purchased plus the freight cost necessary to
transport the inventory to the buyer's place of business (FOB Shipping Point).

Inventory is always recorded at the final cost to the buyer, purchase price less allowances received from the
seller and any cash discounts taken.10

Trade discounts are deducted as part of the initial purchase transaction; they are not a purchase discount.1112
Purchase returns:1314

In inventory account is decreased for the cost of the merchandise returned to the seller less any allowances or
discounts already recorded in the ledger.
💰 Credit Terms:

Generally take the form of 2/10, n/30 where
o
2 is the discount %
o
10 is the discount period in days
o
n is the net (total) amount to pay
o
30 is the number of days after the invoice date that the net amount is due.

Only purchases are subject to the discount; transportation or freight costs paid by the seller on behalf of the
buyer are not subject to a discount.

Cash discounts reduce the cost of inventory for the buyer (credit merchandise inventory)

Cash discounts reduce revenue for the seller (debit sales discounts, a contra revenue account)
🚢 Transportation (Freight) Costs:

FOB Shipping Point - Purchaser is responsible for paying the shipping charges. They are usually prepaid by the
seller and added to the invoice. Buyer adds the shipping costs to inventory. If seller prepays, seller has a
receivable from buyer.

FOB Destination - Seller is responsible for paying the shipping charges and they are recorded as the expense
Transportation Out. Buyer does not make an entry.

Transportation (freight) costs are not subject to a cash discount.
💸 Sales Transactions:

Inventory account is decreased and cost of goods sold is increased for the cost of the merchandise sold.

The freight cost necessary to transport the inventory to the buyer's place of business is an expense in the period
of sale (FOB Destination). Transportation Out or Freight Out are typical accounts used to record the expense.

The selling price of the merchandise sold represents revenue to the seller and is recorded in a separate
transaction.

Trade discounts are deducted as part45 of the initial sale transaction; they are not a sales discount nor a contrarevenue.
Sales Returns:

Inventory account is increased and cost of goods sold is decreased for the cost of the merchandise returned by
the buyer.

Sales returns and allowances is increased and cash or A/R is decreased for the selling price of the merchandise
returned by the buyer.
� Sales Transactions:
When companies sell merchandise inventory, the transaction requires two journal entries:
> the first entry records the revenue from the sale at the selling price
> the second entry decreases the inventory account and records the expense of the sale at cost
Revenue (sales) is recorded at the time the transaction occurs, regardless of whether payment is received from the
buyer. Revenue is always greater the cost of the goods being sold. Inventory is decreased for the cost of the inventory
sold, which includes the price paid for the goods plus all necessary costs of getting the inventory to the company's place
of business and ready to sell, as noted above. The rules of FOB determine whether freight costs are recorded as
transportation out, a selling expense.
✍️ Example 1: Sales Transactions
Inventory is sold for P800 cash (FOB shipping point) in a separate transaction, the purchaser pays P100 of shipping
charges to the shipping company. The total cost of the inventory when purchased was P640 (P800 – P20% x P800).
Account
Debit (Dr.) Credit (Cr.)
Sale
Dr. Cash
800
Cr. Sales
800
COGS
Dr. Cost of Goods Sold
640
Cr. Merchandise Inventory
640
P200 of merchandise purchased is returned by the customer prior to payment:
Account
Debit (Dr.) Credit (Cr.)
Return - Selling Price
Dr. Sales Returns and Allowances 200
Cr. Cash
200
Return - Cost
Dr. Merchandise Inventory
160
Cr. Cost of Goods Sold
160
📅 Periodic Inventory System
Companies may not necessarily be aware of the inventory they hold before they conduct counts, which are done at
regular intervals—weekly, monthly, or quarterly. Here's how the process works:

The party responsible for the count records all the available inventory at the end of the period

Merchandise purchases are recorded in the purchases account

This is moved to the inventory account after the count

This new balance is then applied to the beginning of the new period, after which the process starts again.
💻 PERPETUAL INVENTORY SYSTEM
The perpetual inventory system keeps track of inventory balances continuously. This is done through computerized
systems using point-of-sale (POS) and enterprise asset management technology that record inventory purchases and
sales. It is far more sophisticated than the periodic system of inventory management.
Perpetual inventory is a highly detailed system. Changes in inventory are accurate (as long as there is no theft or damage
to any goods) and can be easily accessed immediately. The COGS account is also updated continuously as each sale is
made. The information collected digitally is sent to central databases in real-time.
🔄 Operating Cycle of Merchandising Business
Exhibit 5-1 Operating Cycle of a Merchandiser
1. It begins when the company purchases inventory from an individual or business (called a vendor/manufacturer).
2. The company then sells the merchandise inventory to a customer.
3. Finally, the company collects cash from customers.
*The cycle is the time of inventory that the business has on hand to sell to customers.
✍️ Example 2: Sales Transactions
P800 of inventory is sold on account, FOB shipping point. The seller pays P100 to the shipping company on behalf of the
buyer, which is added to the seller's invoice. The credit terms offered by the seller are 2/10, n/30. Therefore the total
account receivable is P900 (P800 selling price + P100 shipping charges). The total cost of the inventory when purchased
was P640 (P800 – 20% x P800).
Account
Debit (Dr.) Credit (Cr.)
Sale
Dr. A/R
900
Cr. Sales
800
Cr. Cash
100
COGS
Dr. Cost of Goods Sold
640
Cr. Merchandise Inventory
640
✍️ Example 2 (continued): Sales Transactions
P200 of merchandise purchased is returned prior to payment.
Account
Debit (Dr.) Credit (Cr.)
Dr. Sales Returns and Allowances 200
Cr. A/R
200
Dr. Merchandise Inventory
160
Cr. Cost of Goods Sold
160
When the invoice is paid within the discount period:
Account
Debit (Dr.) Credit (Cr.)
Dr. Cash
688
Account
Debit (Dr.) Credit (Cr.)
Dr. Sales Discounts 12
Cr. A/R
700
✍️ Example 3: Sales Transactions
P800 of inventory is sold on account, FOB shipping point. In a separate transaction, the seller pays P100 of shipping
charges to the shipping company. Therefore the total account receivable is P800 selling price. The total cost of the
inventory when purchased was P640 (P800 – 20% x P800).
Account
Debit (Dr.) Credit (Cr.)
Sale
Dr. A/R
800
Cr. Sales
800
COGS
Dr. Cost of Goods Sold
640
Cr. Merchandise Inventory
640
Shipping
Dr. Transportation Out
100
Cr. Cash
100
✍️ Example 1: Purchase Transactions
When companies purchase goods they intend to sell to customers, the transaction is recorded in the Merchandise
Inventory account. Merchandise inventory is recorded at cost, which includes the price paid for the goods plus all
necessary costs of getting the inventory to the company's place of business and ready to sell. The rules of FOB determine
whether freight costs are included in the cost of inventory.
P800 of inventory is purchased for cash, FOB shipping point. In a separate transaction, the purchaser pays P100 of
shipping charges to the shipping company, which are added to the cost of the inventory. Therefore the total cost of the
inventory purchased is P900 (P800 purchase price + P100 shipping charges).
Account
Debit (Dr.) Credit (Cr.)
Dr. Merchandise Inventory 800
Cr. Cash
800
Dr. Merchandise Inventory 100
Cr. Cash
100
P200 of merchandise purchased is returned prior to payment:
Account
Debit (Dr.) Credit (Cr.)
Dr. Cash
200
Cr. Merchandise Inventory
200
✍️ Example 2: Purchase Transactions
P800 of inventory is purchased on account, FOB shipping point. The seller pays P100 to the shipping company on behalf
of the buyer, which is added to the seller's invoice. The credit terms offered by the seller are 2/10, n/30. Therefore the
total cost of the inventory purchased is P900 (P800 purchase price + P100 shipping charges).
Account
Debit (Dr.) Credit (Cr.)
Dr. Merchandise Inventory 900
Cr. Accounts Payable
900
P200 of merchandise purchased is returned prior to payment.
Account
Debit (Dr.) Credit (Cr.)
Dr. Accounts Payable
200
Cr. Merchandise Inventory
200
When the invoice is paid within the discount period:
Account
Debit (Dr.) Credit (Cr.)
Dr. Accounts Payable
700
Cr. Cash
688
Cr. Merchandise Inventory
12
✍️ Example 3: Purchase Transactions
P800 of inventory is purchased on account, FOB destination. In a separate transaction, the seller pays P100 of shipping
charges to the shipping company. The buyer records only the cost of the merchandise. The credit terms offered by the
seller are 2/10, n/30. Therefore the total cost of the inventory purchased is P800 purchase price.73
Account
Debit (Dr.) Credit (Cr.)
Dr. Merchandise Inventory 800
Cr. Accounts Payable
800
P200 of merchandise purchased is returned prior to payment.
Account
Debit (Dr.) Credit (Cr.)
Dr. Accounts Payable
200
Cr. Merchandise Inventory
200
When the invoice is paid within the discount period assuming credit terms of 2/10, n/30:
Account
Debit (Dr.) Credit (Cr.)
Dr. Accounts Payable
600
Cr. Cash
588
Cr. Merchandise Inventory
12
✍️ Example 3 (continued): Sales Transactions
P200 of merchandise purchased is returned prior to payment.
Account
Debit (Dr.) Credit (Cr.)
Dr. Sales Returns and Allowances 200
Cr. A/R
200
Dr. Merchandise Inventory
160
Cr. Cost of Goods Sold
160
When the invoice is paid within the discount period:
Account
Debit (Dr.) Credit (Cr.)
Dr. Cash
588
Dr. Sales Discounts 12
Cr. A/R
600
📉 Inventory Shrinkage
When a company takes a physical count of its inventory, should it reasonably expect to find all of the inventory items
present and accounted for? Unfortunately, this is not always the case. Inventory could have been stolen (e.g., shoplifting)
or damaged, disposed of, and not disposed of as such (e.g., the contents fell off the shelf of the warehouse or was
damaged by the fall and was disposed of by the cleaning crew). Although companies try to protect their inventory
through proper internal controls, inventory losses or shrinkage still occur. Under the matching principle, these losses are
recorded as expenses in the period in which they occur to match them against the revenue earned. Although the text
suggests that they should be recorded as cost of goods sold, in practice they may be recorded in a separate inventory
shrinkage expense account recorded within cost of goods sold.
Example: The balance in the Merchandise Inventory account in the general ledger was P300,000 before adjustment. A
Physical Inventory was taken and the value of the Merchandise on hand was P294,000.
Adjusting entry required:
Account
Debit (Dr.) Credit (Cr.)
Dr. Cost of Merchandise Sold 6,000
Cr. Merchandise Inventory
6,000
📊 Income Statement Summary
P
Gross Sales
P
500,000
Less: Sales returns & allow.
25,000
Sales Discounts
3,000 28,000
Net Sales
472,000
Cost of Merchandise Sold
294,000
Gross Profit
178,000
Operating Expenses:
Selling Expenses
50,000
Admin Expenses
48,000
Total Operating Expenses
98,000
Income from Operations
109,000
Other Revenue, Interest Revenue 1,000
Other Expenses, Interest Expense 300
700
Net Income
P102,700
📊 Ratio Analysis: Overview and Categories
Ratio Analysis Diagram
The diagram shows the breakdown of Ratio Analysis into key areas:

Solvency Ratio (Leads to Liquidity Ratio and Turnover Ratio)

Operating Performance (Leads to Operating Efficiency Ratio and Profitability)

Risk Analysis (Leads to Business Risk, Financial Risk, and External Liquidity Risk)

Growth Analysis (Leads to Growth rate)
Purpose and Limitations of Ratio Analysis
Purpose of Ratio Analysis

Ratios help compare current performance with previous records.

Ratios help compare a firm's performance with similar competitors.

Ratios help monitor and identify issues that can be highlighted and resolved.

Ratios help with future decision making.
Limitations of Ratio Analysis:

Ratio analysis information is historic – it is not current.

Ratio analysis does not take into account external factors such as a worldwide recession.

Ratio analysis does not measure the human element of a firm.

Ratio analysis can only be used for comparison with other firms of the same size and type.

It may be difficult to compare with other businesses as they may not be willing to share the information.
Definition and Importance
Ratio analysis – This method of analyzing the Financial Statements (FS) uses the relationship among the FS accounts to
measure the financial condition and performance of an enterprise. It uses mathematical comparison of accounts or
categories.
Why is financial ratio analysis important?
Analyzing your company's financial ratios can provide you with valuable insights into profitability, liquidity, efficiency
and more. These ratios can help you visualize how your company has performed over a given period of time.
FINANCIAL RATIOS CATEGORIES:
There are four most common basic categories of financial ratios:
1. Liquidity ratios
2. Asset utilization or efficiency or activity ratios.
3. Profitability ratios
4. Leverage or solvency ratios.
1. Liquidity Ratios
1. LIQUIDITY RATIO – Analyze the ability of a Company to pay off its current liabilities as they become due as well as
long-term liabilities as they become current.

Current Ratio

Quick Ratio or acid test ratio

Working Capital
Current Ratio:
Quick Ratio:
2. ASSET UTILIZATION OR EFFICIENCY RATIOS – measures how well the business utilizes its assets to generate income.

Accounts receivable turnover ratio

Days Sales in Accounts Receivable

Inventory Turnover Ratio

Days in inventory

Asset Turnover Ratio
Accounts Receivable Turnover Ratio:
Days Sales in Accounts Receivable:
Inventory Turnover Ratio:
Days in Inventory:
Days in Inventory:
3. PROFITABILITY RATIOS – focus on the business return the business investments based on its relative level of resources
and assets.

Gross profit Ratio

Net Profit Ratio

Return on Asset Ratio

Return on equity ratio
Gross Profit Margin Ratio:
Net Profit Ratio:
Return on Asset Ratio:
Return on Equity Ratio:
4. SOLVENCY RATIO – measures the business ability to sustain its operations on going concern by comparing its longterm debts with assets and equity.

Debt ratio

Debt to Equity Ratio
Debt Ratio:
Debt to Equity Ratio: